In a particularly hot seller’s market, investors can struggle to find good deals. As a result, many look to alternative sources to find real estate. This leads many investors to ask me: Ryan, how do you buy REO properties?
REO, or real estate owned, properties have been foreclosed upon by banks. And after this foreclosure, banks categorize these homes on their books as REO assets. Investors can find these homes on the MLS or at auction, and they buy them just like any other: offer, acceptance, and closing.
I’ll use the rest of the article to explain the details of REO properties and how to buy them. Specifically, I’ll cover the following topics:
- What’s an REO Property?
- Additional Post-Foreclosure Steps for REOs
- Why Investors Consider Buying REO Properties
- How to Buy an REO Property
- Alternatives to REO Properties
What’s an REO Property?
Investors must first understand the bank foreclosure process to understand REO properties.
When banks issue mortgages, the associated properties serve as collateral for the loans. This provides lenders protection in case of default. That is, if a borrower stops repaying a mortgage, the bank can seize – or foreclose on – the property. The bank can then sell this property to recoup its outstanding loan balance. This is one part of the reason why mortgage interest rates tend to be so much lower than other credit (e.g. credit cards, personal loans, etc.). Real estate tends to appreciate in value – or at least retain its value. As a result, banks face less lending risk. They know there’s a good chance that if a borrower stops paying, they’ll recoup the outstanding loan balance via foreclosure and resale of the underlying collateral.
Once a bank has foreclosed on a property, that property becomes an asset on the bank’s books. But, if the bank plans on immediately selling the property, it will be classified as real estate owned, or REO, property. This allows people examining a lender’s accounting records to clearly differentiate between A) property held for investment purposes, and B) foreclosed upon properties intended for immediate sale.
Additional Post-Foreclosure Steps for REOs
After foreclosing on a property, the bank needs to then take some additional steps before it can actually sell the REO home. These steps largely revolve around the actual occupants of the home. If the homeowners who were foreclosed upon refuse to leave, the bank needs to begin eviction procedures. These procedures vary by state and municipality, but they can be time-consuming and costly. And, banks must completely comply with the local eviction laws, or they can end up facing a lawsuit themselves.
Rather than deal with an eviction-related headache, many lenders instead run a “cash for keys” program. They approach the current occupants and offer them money to vacate the premises. This A) saves the bank from the eviction process, and B) avoids an eviction on the occupants’ records.
After the prior owners vacate the premises, banks can begin the resale process. Typically, banks assign responsibility for the marketing and sale of these properties to local real estate agents specializing in REO sales. For investors, this represents an absolute pro tip! If interested in purchasing REO properties in your market, find, introduce yourself to, and build a relationship with the local REO-specializing agents. These people frequently learn about REO properties well before the banks formally list them for sale, providing investors a solid advantage in purchasing REO properties.
Why Investors Consider Buying REO Properties
Now that I’ve provided some background on the REO process, I want to explain why investors should consider buying these properties. Simply put, successful real estate investors know how to find deals. In particularly competitive markets, finding good deals can pose a major challenge.
With REO properties, investors should remember that banks aren’t in the business of selling homes. As a result, many try to clear these properties from their books as quickly as possible. This creates the potential for some serious property bargains.
But, banks also won’t give away these REO properties. Rather, they’ll conduct a cost analysis on each home. Basically, they want to know whether it makes more sense to A) sell it “as is” at a discounted price, or B) put money into renovating the home to sell it for retail on the MLS. If the after-rehab value of a property doesn’t justify the time and cost of renovations, many banks will instead go with the “as is” sale option.
For investors, this creates a tremendous opportunity. Distressed homes – the condition of most REO properties – do not qualify for traditional financing. Banks won’t issue mortgages for homes that require major repairs. Consequently, only investors using hard money loans or cash can purchase these properties. This means two things. First, investors have less competition for REO properties than for those listed on the MLS. Second, due to the distressed nature of these properties, banks recognize that they must sell them at a discount, generally trying to just recoup their loan balance – not necessarily make a profit.
How to Buy an REO Property
Broadly speaking, banks use one of two strategies to sell REO properties. Which one they choose depends on the home’s condition.
The first approach involves properties that A) do not need repairs, or B) have been repaired by a bank post-foreclosure. With these homes, banks will sell them like any other property by getting them listed on the MLS with a local real estate agent. From an investor’s perspective, these homes do not offer any better or worse deals than any other homes listed on the MLS.
The second approach involves the distressed properties that banks have decided not to renovate. Due to the fact that these homes do not qualify for traditional financing, banks instead list them for sale with auction services (e.g. auction.com). These auctions let banks sell REO properties en masse. Lenders accrue holding costs for every REO property on their books. Banks also have capital ratios – liquidity requirements – they must maintain. Selling these properties as quickly as possible increases liquid assets and supports these capital ratio requirements.
For investors looking to purchase REO properties under either of the above approaches, the process proves largely the same as purchasing any homes. You need to make an offer, wait for seller acceptance, then close on the deal.
With that said, real estate wholesalers need to be cautious about purchasing REO properties. When selling homes, many lenders impose title and deed restrictions on the transaction. These restrictions prevent wholesalers from going under contract then assigning that contract to another real estate investor.
Alternatives to REO Properties
Yes, REO properties can provide investors opportunities for great deals. But, especially during the COVID-related moratorium on foreclosures of homes purchased with government-backed loans, the supply just doesn’t exist. And, even when investors do find a good REO deal, they can’t reliably count on finding consistent deals. As such, we just don’t recommend this as a go-to strategy for investors.
Instead, we highly recommend that investors pursue off-market properties. These homes face less competition than both REO and MLS properties, and investors can find some incredible deals. If interested in this marketing strategy, check out our Investor’s Edge software. This tool provides investors information on over 160 million properties, and it’s a great way to find deals!